Nervous Asia Has Good Reasons to Fear Euro Zone Crisis

Patrick Jenkins

Monday, 10 Oct 2011 | 8:04 PM ETFinancial Times

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A few weeks ago, China’s biggest bank by customers dispatched a quiet delegation of top officials to Greece. Agricultural Bank of China was not there to make an opportunistic acquisition of its Greek namesake or to do a bit of Chinese empire building. This was a more fundamental trip, part of a eurozone fact-finding mission that bears testimony to one thing — China is worried about the state of the eurozone. And it is not alone among its Asian neighbors.

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Over recent weeks, Asia’s largely dispassionate observation of the economic slowdown in Europe has given way to fears that the eurozone’s sovereign debt woes could trigger deep problems for the broader Asian economy and its financial centers.

Singapore and neighboring Southeast Asian nations are among the most vulnerable to direct disruption, because so much of their economic activity depends on international trade. Even the least bearish bankers are braced for at least a repeat of the 2008 hit to Asia’s economy — and its banks — when the first flush of the global financial crisis led to two quarters of negative growth in the region.

The old idea of Asia, or many other emerging markets for that matter, being a safe haven from troubles in developed markets, has been discredited. As 2008 showed, there is no such thing as a decoupled economy in a globalized world.

Asia today faces two waves of pain. The direct financial impact will be felt as trading volumes on financial markets fade, just as they have in the west. When markets are as jittery as they are now, it seems geographic diversification counts for little — only a sock under the bed will do.

The drying-up of trade links, as exporters lose customers, will compound the financial slowdown. Nowhere is this more powerful than in China, where exports still account for close to two-thirds of GDP and banks are the lifeblood of that trade flow.

Proponents of the Asian dream are, of course, right to point out that any impact will be cushioned. The region has liquid banking systems, with high savings rates, and capital ratios solidified by tougher rule-making in the wake of the 1997 Asia crash, which should guard against the damaging evaporation of funding at many banks in the eurozone.

There are also valid arguments to support the fundamental strengths of the region’s economies — hikes in property prices are supported by a powerful trend of urbanization that is quite different from the speculative development that spelt trouble in Ireland and Spain.

But that is only half the story. There is a powerful reason why Asia’s infamous property bubble — spanning China, Singapore and Hong Kong — will burst and take the region’s banks with it.

Forget lenders’ defense about the tiny property risks they are running. Yes, their nominal exposures are limited. (AgBank, for example, reports barely a 0.5 percent non-performing loan ratio on its mortgage lending, and 1.2 percent on property developer loans. And together, those categories account for less than a quarter of overall lending.) But a blinkered focus on explicit real estate exposures misses the point.

The real risk lies in the danger of a domino effect. There are at least two potential starting points for it to go wrong, pretty quickly.

First, the obvious trade route. If Chinese companies see export volumes shrink, they are likely to struggle to meet loan repayments (and remember, China’s economic stimulus was administered via enforced lending expansion, to the tune of 30 percent in 2009 and 20 percent in 2010). That in turn could prompt banks to seize collateral underpinning the loan, which according to some estimates comprises real estate to the tune of more than 90 percent.

A second likely trigger for problems is banks’ lending to “trust companies”, the lightly regulated financial companies that have filled the gap left by banks in lending to property companies and are now starting to show signs of strain. The risks of an unraveling Chinese real estate story look substantial.

Investors have been rapidly realizing as much. Chinese banks are now valued on stock markets at barely the value of their underlying assets — half the rate of even six months ago, and almost in line with some eurozone peers. The response of policymakers on Monday, to pledge an intervention to buy Chinese bank shares on the stock market, was bold.

However, back in the eurozone, there is still profound uncertainty about whether a solution can be found that preserves the region’s integrity and keeps the region’s banks afloat.

If it can’t, Chinese banks and policymakers might yet be back on a aeroplane to Europe to knock some heads together.